Investing is an excellent way to increase your wealth over time. However, with all investments, there is an inherent risk involved.
While some risks are small, others can be significant, resulting in the loss of your investment or reduced returns.
Understanding the different types of investment risk can help you make informed investment decisions.
In this blog, we will detail five types of investment risk.
Market risk
Market risk is the most common type of investment risk. It refers to the possibility of losing money due to the overall performance of the financial markets.
This risk is prevalent in equity and bond markets, where prices can fluctuate due to a range of factors such as economic data, company performance, and global events.
Market risk cannot be eliminated, but it can be managed by diversifying your investments across different asset classes.
Interest rate risk
Interest rate risk is the possibility of losing money due to changes in interest rates. This risk is prevalent in bond markets, where bond prices and interest rates are inversely related.
When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.
This risk can be managed by investing in bonds with different maturity dates, as longer-term bonds are more sensitive to interest rate changes.
Credit risk
Credit risk is the possibility of losing money due to the failure of a borrower to repay a loan or debt.
This risk is prevalent in the bond market, where bond issuers may default on their interest payments or principal repayment.
It can be managed by investing in high-quality bonds issued by financially stable companies or governments.
Inflation risk
Inflation risk is the possibility of losing money due to inflation eroding the purchasing power of your investment.
Inflation reduces the value of money over time, and if the rate of inflation is higher than the rate of return on your investment, you will lose money in real terms.
This risk can be managed by investing in assets that have the potential to outpace inflation, such as stocks or real estate.
Liquidity risk
Liquidity risk is the possibility of losing money due to the inability to sell your investment quickly or at a fair price.
This risk is prevalent in illiquid assets such as real estate or private equity, where there is a limited market for buyers and sellers.
It can be managed by investing in liquid assets such as stocks or bonds, where there is a large and active market for buyers and sellers.
